Toll, Lennar: 2 Good Ways to Play the Housing Recovery

NEW YORK ( TheStreet) -- Signs of a significant housing recovery are ubiquitous. There's little controversy that the recovery is valid and enduring. As long as credit is cheap and available, as long as the pent-up demand is greater than the supply, it will endure.

Housing starts decreased 3% last month from October to a seasonally adjusted annual rate of 861,000, the Commerce Department said Wednesday. Since November 2011, new home construction was up 21.6% . . . . Construction of single-family homes, which made up two-thirds of housing starts last month, dropped 4.1% in November to a rate of 565,000 units. Single-family construction was up 22.8% from a year earlier.

As a Barron's news story concluded, "The figures were below expectations. Economists surveyed by Dow Jones Newswires had forecast overall housing starts would drop to a seasonally adjusted annual rate of 865,000, which would have been a 3.2% decline from October's previously reported figures."

The upside of the Commerce Department's report was summarized by Dave Lutz, a trader at Stifel Nicolaus, who opined, "Billings by U.S. architecture firms increased in November at the fastest pace in five years, a sign construction will pick up next year as businesses invest in commercial projects. The American Institute of Architects Billings Index climbed to 53.2 last month, the highest level since November 2007, from 52.8 in October."

Lutz reminded us that the index has risen for six straight months, the longest winning streak in its 17-year history. All I can add is that when the Architects Billings Index rises month after month that bodes well for the economy and for the home building industry specifically.

Jim Cramer and Stephanie Link actively manage a real money portfolio for his charitable trust- enjoy advance notice of every trade, full access to the portfolio, and deep coverage of the latest economic events and market movements.

Earlier this month luxury-home builder Toll Brothers ( TOL) let it be known that their quarterly profits surged in the fiscal fourth quarter. TOL reported that net signed contracts for building homes were more than $684 million. That's up 75% from the year-ago quarter.

TOL also reported the number of units surged to 1,098 which is a 70% improvement from last year. In fact The Wall Street Journal reported that "...on a per-community basis, TOL's net signed contracts were the highest for any fiscal year since 2006."

Yearley added, "As household formations accelerated and unsold home inventories dropped to record lows, the industry took further steps toward a sustained housing recovery." For the quarter ending Oct. 31, Toll Brothers reported a profit of $411.4 million. This translated to $2.35 a share, a monumental improvement over the same quarter last year when TOL's profit was just $15 million.

As the chart below illustrates colorfully, this is a big improvement in TOL's earnings. The Journal article pointed out that the latest quarter included a net tax benefit of almost $351 million. Yet as the chart points out quarterly revenues have been rising sharply, up 48% to nearly $633 million.

Confidence among U.S. homebuilders climbed in December for the eighth straight month, reaching its highest level in more than six years and adding to signs that real estate is aiding the economic expansion.

Toll Brothers stock has had a good run since its Nov. 15th intraday low of $28.50. So investors may be well-served to wait for a correction or some weakness before investing. But don't wait too long or for too big of a price pullback.

As Jim Cramer and Stephanie Link wrote to their Action Alerts Plus subscribers last week, "We like its TOL dominance, backlog of homes, pricing improvement and relative better balance sheet compared with its peers."

TOL's average price of homes delivered rose to $582,000 compared to $576,000 in the third quarter and $565,000 in the year-ago fourth quarter.

The company estimates that in the fiscal year ahead it will deliver between 3,600 and 4,400 new homes priced at an average of around $612,500. More signs of progress in the housing sector, the drop in new single-family housing starts in November notwithstanding.

One of the home-building stocks that reacted to Wednesday's report on November's new home housing starts was Lennar ( LEN) the Miami, Fla.-based company. LEN's homebuilding operations include the construction and sale of single-family attached and detached homes as well as the purchase, development and sale of residential land. It's well-suited to benefit from the housing recovery.

The company also provides mortgage financing, title insurance and closing services for the buyers of homes. In addition, it invests in distressed real estate assets, as well as engages in sourcing, underwriting, pricing, and monetizing real estate and real estate related assets and providing similar services to others in markets across the country.

A recent report in The Wall Street Journal announced that LEN has secured a $1.7 billion loan from China Development Bank, a government-controlled financial institution. The loan is for two very large housing projects that LEN will undertake in the San Francisco, Calif. area.

As the chart colorfully shows, LEN's quarterly EPS must rebound sharply to sustain its current price-per-share, which is close to a 52-week high. Lennar will report its latest quarterly numbers and step into the earnings confessional on Jan. 11. Investors and potential investors will be listening closely.

If you decide to speculate on shares of TOL and LEN I encourage you to have a carefully predetermined stop-loss strategy in place to limit the downside risk.

Conventional wisdom tells us, "You've got to cut your losses and let your winners ride." Now's as good a time as any to apply that wisdom as we end a volatile financial year and enter a new, promising one.

As of the time of publication the author is not long shares of any company mentioned in this article.